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Bridge Loan Definition
A bridge loan is a type of short-term loan which is used by an individual or company as they secure permanent financing or deal with an existing obligation. It provides immediate cash flow to allow short term obligations to be met. These loans have high interest rates and usually, go up to one year since they are short term. They are backed up by collateral such as inventory or real estate.
A Little More on What is a Bridge Loan
These loans are used to bridge the gap when there is a need for financing, and it’s not yet available. They are also known as swing loans, gap financing or interim financing. These loans can be customized to meet the requirement of different situations. Both businesses and individuals use them.
Businesses utilize these loans when they need to cover the current expenses as they wait for long-term financing. For example, a company may decide to use a bridge loan to cover the interim expenses if it is conducting a round of equity financing that is expected to complete in about six months. The current expenses to be covered include, utilities, rent, and payroll, among many others.
Sometimes bridge loans are used in the real estate industry. A buyer who may be having a lag in the purchase of one property and the sale of another may decide to use a bridge loan. However, these real estate bridge loans are only to borrowers who have good credit ratings and also low debt-to-income ratios.
The bridge loans provide flexibility to a buyer who is awaiting the sale of his old house, by rolling together the mortgages of the two homes. The lenders mostly provide bridge loans which are worth 80% of the combined value of the two properties. So a borrower in need of financing must then have significant home equity in the property or considerable cash savings.
When compared to traditional loans, bridge loans have a faster application, approval and funding process. They also have higher interest rates and large origination fees. The reason why most borrowers accept these terms is that they need fast and convenient access to funds. Most of them plan to pay off this loan quickly using low-interest, long-term financing. Most of these loans lack repayment penalties.
References for Bridge Loan
Academic Research on Bridge Loan
- Counterparty risk and the pricing of defaultable securities, Jarrow, R. A., & Yu, F. (2001). the Journal of Finance, 56(5), 1765-1799. This paper presents a generalization of the existing reduced-form models to include default intensities that depend on the default of a counterparty.
- Theory of risk capital in financial firms, Merton, R. C., & Perold, A. (1993). Journal of applied corporate finance, 6(3), 16-32. This paper discusses the theory of risk capital in financial firms.
- The Home Mortgage Bridge Loan Assistance Act of 2012, Hockett, R., & Campbell, M. (2012). This article attempts to replicate the benefits associated with HEMAP while applying the lessons learned since HEMAP was implemented several decades ago.
- The low‐income housing tax credit as an aid to housing finance: How well has it worked?, McClure, K. (2000). Housing Policy Debate, 11(1), 91-114. This paper analyses a sample of Missouri developments to find out if all the tax credits are syndicated and if all the syndication proceeds are used in settlement of developmental costs.
- The entry of commercial banks into the securities business: A selective survey of theories and evidence, Rajan, R. G. (1996). Universal banking: Financial system design reconsidered, 282-302. This article attempts to show the importance of the dynamics of the growth of markets and institutions in the developing countries and former communist economies.
- Capital contribution or a loan?, Brighton, J. A. J. (2002). American Bankruptcy Institute Journal, 21(5), 1. This is a study that focuses on the factors influencing a business’s decision in deciding whether to use a loan or capital contribution to finance its activities.
- Bridge Loan: Case of Small Loan Company Variation and Copatibility, Yulin, C. (2011). Journal of Financial Development Research, 12, 014. This paper presents a study in the mechanisms of the variation and the reposition of small loan companies and the issues resulting from policy changes based on the four cases of small loan companies in Laiwu, Shandong.
- A Loan by Any Other Name-The Advent of the Rate Spread Home Loan, Hotchkiss, L. I. (2008). Bus. Law., 64, 653. This paper investigates the emergence and growth of the Rate Spread Home Loan in the market.
- The valuation of mortgage loan commitments using option pricing estimates, Kutner, G., & Seifert, J. (1989). Journal of Real Estate Research, 4(2), 13-20. This article uses the context of the theory that was developed by Black and Scholes, to value mortgage loan commitments.
- Corporate capital structure decisions: evidence from leveraged buyouts, Roden, D. M., & Lewellen, W. G. (1995). Financial Management, 76-87. This paper tests a set of hypotheses developed in the previous literature about the determinants of corporate capital structure decisions by analyzing the composition of the financing packages used in a large sample of leveraged buyout transactions.